Are Fixed Annuities Right For You? Some Pros and Cons

by Jacques Sprenger on December 29, 2008

Should you own fixed annuities? Here’s a short discussion of the pros and cons of a fixed annuity, along with my own personal experience with this type of financial instrument.

The different types of annuities are so complex that an ordinary citizen may find it difficult to find a way to decide if they are good financial instruments. Just to give you a taste of the types of annuities available, let me cite the following terms: fixed annuity, equity-indexed annuity, deferred annuity, fixed period vs. lifetime annuity, single premium vs. flexible premium annuity, variable annuity. Enough complexity to confuse a Wall Street broker (hey, that already happened, right?).

fixed annuities, variable annuities
Image by AARP.

For purposes of this article, I’d like to take a look at the type of annuity I do own — the fixed annuity:

Fixed Annuities, Some Pros and Cons

My wife and I decided a few years ago to invest in a fixed annuity with a 10-year life span. After 4 years, we’ve made a 13% gain through an option that allows you to apportion your investment to the Dow Jones, S&P 500, Nasdaq or simple low interest. The first year of the annuity guaranteed us 10% interest, no matter what (as per Allianz).

Yes, we chose Allianz (no commission for me) because it is an international insurance company with an outstanding financial record and huge assets. The main advantage of owning such an investment? To manage your risk better. In our case, we sleep better at night knowing that our risk is minimal to non-existent. A big plus is that we don’t pay taxes on the gains until the end of the contract, and even then we may opt to receive monthly payments instead of a lump sum. We will pay a regular income tax, however, when we withdraw a certain amount every year (up to 10%), but that of course depends on when we do choose to withdraw.

Forced Savings and The Fixed Annuity

Please remember to shop around for the best deal; not all fixed annuities are equal in benefits. Consider the fixed annuity as a type of savings that will allow you to reach a certain goal, such as college for your kids (though a 529 college savings plan is another option). You can choose to make additional payments into your initial investment according to your budget. An automatic monthly deduction may be a good choice for “forced” savings. But the moment you decide to withdraw the capital before the expiration of the contract, a hefty penalty is applied, so do it only in an absolute emergency. You’ll avoid penalties altogether if you build an emergency fund separately!

The Fixed Annuity and Retirement

In these perilous financial times, a fixed annuity may be a better choice than stocks and bonds for some individuals. They may be a better fit for you if you’d like to be more conservative and need to tone down the risk in your investment portfolio (according to your risk profile or because of your current place in life). You could decide to invest for only 5 years, giving the market time to recover; or you may want to use it for retirement if you are 55 and over, and obtain a lump sum or a monthly payment for as long as you live. In any case, make sure you consult a financial planner or your insurance broker (ask him/her what their commission is for a fixed annuity, a fact that may sway their advice).

Risk and Loss Protection

Another big plus for fixed annuities is that they are protected by the states for as much as $500,000 (check your state for details). Protection does not come from a government agency, but from an association called a Guaranty Association (again, covered per state). The level of protection varies according to the type of annuity you have. Since fixed annuities have some “guarantees” associated, then they do have protection coverage up to a certain amount.

What About Variable Annuities?

Before you buy a variable annuity, read on. Variable annuities are also protected up to certain limits when there are problems with the underlying insurer; but there won’t be any protection from losses due to stock market performance. Remember that the variable annuity is a stock market based instrument. If the market goes down, so does the variable annuity. This instrument is often recommended by insurance agents and financial planners as a form of retirement vehicle, although a 401K does the same job with much better tax advantages.

Variable annuities haven’t been very popular financial instruments and aren’t well recommended by many financial gurus (Suze Orman hates them with a passion!) or by informational sites (e.g. Smart Money) for the general populace, again, because there are investment alternatives out there that are considered superior for most of us.

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{ 2 comments… read them below or add one }

1 Julius August 12, 2009 at 4:26 pm

For some more information on types of annuities, their pros and cons, FAQs, and questions and answers on annuities visit newretirement.com.

2 Building Measurement May 19, 2011 at 4:40 am

Great post..A friend told me about this page. I’ve been looking annuities for a while. It’s good to get a breakdown of all the pluses and minus’. I think they are important part of anyone’s portfolio. The only thing I don’t like is the penalty for withdrawing early. With the stock market looking unappealing whilst the financial crisis takes hold.. annuities are ideal for many I think.

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